S&P enters budget debate by lowering U.S. credit rating outlook

Stocks tumbled when Standard & Poor's announced that partisan budget bickering has led the agency to downgrade the U.S. credit rating outlook. Image: Flickr/My Alternative Photos CC-BY-SA

Citing doubt that Congress can solve its debt problem, Standard & Poor’s downgraded the long-term credit rating outlook for the U.S. Despite the uncertainties surrounding partisan budget battles, the current top credit rating for U.S. sovereign debt remained unchanged. Investors and traders panicked on the news and stocks plummeted.

Budget battle affects U.S. credit rating

Budget gridlock in Washington is starting to affect the audience politicians care most about with the downgrade of the long-term U.S. credit rating outlook. Monday Standard & Poor’s lowered the U.S. credit outlook based on the risk that politicians could fail to agree on a plan to reduce the federal budget deficit to sustainable levels. Standard & Poor’s is one of three major agencies investors rely on to evaluate public and private debt scenarios. S&P credit ratings are viewed as a reliable measure of an investor’s risk in buying debt, a key factor in determining interest rates. S&P downgraded the U.S. long-term credit rating outlook from “stable” to “negative.” S&P maintained the country’s current top AAA credit rating, but a negative outlook means there is a one-in-three chance that the agency could further downgrade the U.S. credit rating within two years.

S&P move highlights risks of U.S. debt

S&P’s downgrade of the long-term U.S. credit rating outlook raises the stakes for Congress and the Obama administration to reach an agreement on a plan to reduce the federal budget deficit, which has reached about $1.5 trillion — the equivalent of almost 10 percent of U.S. gross domestic product. If allowed to continue growing at the present rate, the federal budget deficit could raise the cost of borrowing and further devalue the dollar, which would exacerbate the problem by degrading the government’s ability to finance the deficit. A bipartisan agreement on a long-term deficit reduction plan is not realistically expected until the conclusion of the 2012 elections. If a viable solution is not reached by then, S&P could make good on its threat to downgrade the current U.S. AAA credit rating. Such a move would send mortgage rates soaring and trigger a relapse of the credit crunch, which would send U.S. economic recovery off the rails.

Treasury tries to deflect effect of S&P announcement

The Treasury Department said S&P’s decision to lower the long-term U.S. credit rating outlook to negative “underestimates” U.S. leadership. At a press conference in Washington, a Treasury official said the cost of borrowing is not expected to rise on news of the S&P downgrade and reiterated the soundness and liquidity of U.S. debt. The official also said S&P should avoid making decisions based on politics and let the political momentum to reduce deficits run its course. Before those remarks were made, stocks stumbled out of the gate on Monday, losing more than 1 percent in early trading. Blue chip stocks shed more than 200 points as investors worried that the S&P downgrade could increase the cost of financing growth worldwide.